Shareholder Representative Services has just released a new report, its 2013 M&A Post-Closing Claims Study. The report is based on a review of claim activity in 420 private company transactions over the past year. Two thirds of deals had post-closing issues to report. Some of the study's key findings:

Earn-out milestones for tech and other deals outside of life sciences were achieved 50% of the time

18% of deals had at least one claim made in the final week of the escrow period.

Final escrow releases were delayed due to claims in 30% of deals.

73% of deals with post-closing purchase price adjustment mechanisms saw adjustments, which were more often buyer-favorable than seller-favorable. 27% of adjustments were ultimately modified from the initial amount claimed.

10% of earn-out milestones that were initially claimed as missed eventually resulted in a payout for shareholders.

Tax claims became more frequent due to the average target being a more mature taxpayer. In addition, state and local governments have become more aggressive about revenue collection, especially for sales and use taxes.

More CurrentTV corporate law thoughts. Is is possible that the managers of CurrentTV violated their Revlon duties in selling the company to Al-Jazeera? Glenn Beck seems to think so...

Beck was on his radio show today and made it known that he inquired into purchasing Current Media, Inc. on behalf of his Mecury Radio last year. That inquiry was, to put it politely, rebuffed by Al Gore:

GLENN: Let me ‑‑ let me tell you what happened. How many months ago? I don’t know how many months ago. When we found out that Current TV was going to go up for sale, it was rumored to be, what, $250 million is what they were asking, and I don’t have $250 million lying around, but we wanted access to 60 million households and so we discussed it and we thought we can somehow or another find $250 million, $300 million. Somehow or another we might be able to do it.

Now, we didn’t know if we were willing to trade whatever it is we would have to trade to be able to get access to that kind of money. Do I want that kinds of debt? Do I want a partner? What am I going to have to give up? So we were very ‑‑ we were exploring and we thought, well, before we put any real thought into this, let’s call Al Gore. Let’s call Current and find out. And I wasn’t involved in any of the negotiations by any stretch of the imagination. We have people who are negotiating all of these things. We called them and said let’s just look. Because wouldn’t I love to buy Current. And so our people called, and a rough outline of the conversation is this, and I’m only telling you this because the Wall Street Journal has said that it is there. We have conversations that are confidential and we don’t ‑‑ I’m not going to tell everybody’s story on the air. The Wall Street Journal is reporting this story. So I want to give you the full story.

So we call up, and I don’t even know who we talked to but, you know, it was the person handling the negotiations. And our person says, “We would like to talk to you about buying Current.” Great, great, fantastic. So who is Mercury exactly? “Umm… (mumbling)… but let’s talk about, so how much are you…” “Excuse me. Who is Mercury exactly?” “It’s a wholly owned subsidiary of Glenn Beck.” “Excuse me?” “It’s Glenn Beck’s company.” “It’s Glenn Beck’s company?” Silence. “That one is going to probably have to go to the vice president. Al Gore’s probably going to have to answer that one. I don’t… we’ll call and we’ll get an answer and then we’ll call you back.” No kidding, within 15 minutes, brrrppp, we get a call back. “Yeah, umm‑umm, no, not even interested. We ‑‑ our legacy is too important and there would quite frankly be too many people, too many friends that the vice president would have to explain why he’s selling to Glenn Beck.”

First thing: If they are selling the company for cash, should the political ideology of the buyer enter into equation if a director wants to comport with his obligations under Revlon? I'll spare you the details, but in his discussion, Beck makes a pretty good case that, no, if you are going to cash out, thoughts about your legacy aren't compatible with your obligations to shareholders under Revlon. Of course, there is no obligation to run an auction under Revlon, but the managers conducting the sale have to be motivated by maximizing shareholder value rather than the political ideology of potential acquirers.

Second, one might say, hey, it's a private company, who has standing to sue anyway? Turns out -according to an S-1 filed as part of Current's failed 2008 IPO that both DirectTV and Comcast were shareholders of the CurrentTV. They have standing. I wonder if they cared about the sale process?

So many corporate law questions in this simple little deal. Whodathunkit?

OK, so Dec. 21 came and went without any Mayan apocalypse...we went over the fiscal cliff and the only thing that happened was that my suspicion that our Congress is useless was confirmed. OK, so with all that behind us, might as well get back to blogging! Apologies for the light blogging of late. Lots of things and what with the end of the world, didn't seem worth it.

Anyway, the big news of the day is the fact that Time Warner Cable subscribers have had CurrentTV pulled from their line-ups following the announcement of Current's acquisition by Al-Jazeera for $400 million. First, people watch CurrentTV? Well, if they do, fewer of them do so now. According to a memo released to employees by CurrentTV's CEO Joel Hyatt, cable carrier Time Warner Cable refused to consent to the transaction and as a result immediately dropped CurrentTV from its channel lineup. TIme Warner Cable has something on the order of 15 million subscribers and none of them will be able to watch Current/Al-Jazeera going forward. That's 25% of Current's current subscriber based. Ouch.

From Time Warner Cable's point of view, dropping the Current/Al-Jazeera network is a little odd. I mean, commercially, there's nowhere to go but up for the new Al-Jazeera when compared to Current's ratings.

In any event, for the M&A lawyers around, you'll be familiar with the mechanics of how this probably went down. CurrentTV is privately held, so the exact details will remain shrouded for the timebeing.

In its carriage contracts with CurrentTV, Time Warner Cable (and presumably all the other cable carriers) included a change of control provision that permitted Time Warner Cable to terminate carriage in the event of a change of control. This was, no doubt, dutifully spotted by junior associates for Al-Jazeera's counsel during the diligence process and a condition placed in the merger agreement requiring consents by all the cable carriers before closing. This condition was likely waived (with a price renegotiation?) at closing.

Just today, CurrentTV personality - and former Governor of Michigan - Jennifer Granholm announced she would leave the network following its acquisition by Al-Jazeera. Presumably, Al-Jazeera had locked up key employees prior to signing its acquisition agreement. So one must assume that Granholm - one of the network's "leading personalities" - wasn't all that important, or that they weren't able to lock her up, and the price was negotiated down as a result. Or not.

Just wandering through these press clippings makes for a great exam fact pattern! My new students for the Spring should start paying attention!

In that case, on Oct. 26, 2012, the United States District Court for the Southern District of Ohio granted summary judgment in favor of Credit Suisse, holding that, under New York or Ohio law, plaintiff Pharos Capital Partners failed to prove it justifiably relied on Credit Suisse in connection with its private equity investment in National Century Financial Enterprises (a business that was later found to be fraudulent) because Pharos expressly disavowed any such reliance in a letter agreement with Credit Suisse.

According to Bingham:

The decision is significant for the financial industry because it enforces a party’s representations in an agreement that it was relying on its own due diligence investigation in connection with its investment, rather than any alleged representations made by a placement agent. Prior to the decision in Pharos, many courts have been reluctant to enforce such agreements to defeat claims for fraud and negligent misrepresentation.

When negotiating an acquisition agreement, it often appears that the other side is negotiationg language without any real knowledge of what the law actually is. One area where this is often the case is anti-sandbagging provisions. This article frames the sandbagging/anti-sanbagging issue and provides a useful summary of the law in several of the most relevant jurisdictions:

In Delaware, the buyer is not precluded from recovery based on pre-closing knowledge of the breach because reliance is not an element of a breach of contract claim. The same is true for Massachusetts and, effectively, Illinois (where knowledge is relevant only when the existence of the warranty is in dispute). But in California, the buyer is precluded from recovery because reliance is an element of a breach of warranty claim, and in turn, the buyer must have believed the warranty to be true. New York is less straightforward: reliance is an element of a breach of contract claim, but the buyer does not need to show that it believed the truth of the representation if the court believes the express warranties at issue were bargained-for contractual terms.

In New York, it depends on how and when the buyer came to have knowledge of the breach. If the buyer learned of facts constituting a breach from the seller, the claim is precluded, but the buyer will not be precluded from recovery where the facts were learned by the buyer from a third party (other than an agent of the seller) or the facts were common knowledge.

Given the mixed bag of legal precedent and little published law on the subject, if parties want to ensure a particular outcome, they should be explicit. When the contract is explicit, courts in California, Delaware, Massachusetts and New York have either enforced such provisions or suggested that they would. Presumably Illinois courts would enforce them as well, but there is very little or no case law to rely upon.

As we've noted before, purchase agreements relating to the acquisition of a private target often contain one or more post-closing purchase price adjustments (for example a working capital adjustment). As this K&E M&A update notes

While the appeal of purchase price adjustments is indisputable, they are often subject to postclosing disputes. One of the drivers of these disputes is inattention to the details of drafting the adjustment provisions, often exacerbated by the fact that these clauses straddle the realm controlled by the legal practitioners and that managed by the financial and accounting experts.

The update offers a plethora of tips on drafting these provisions properly.

The M&A Market Trends Subcommittee of the ABA just announced that the 2009 Private Target Deal Points Study is now available to Subcommittee members here. Highlights of the 2009 Study were presented last month at an ABA telecast on "M&A Negotiation Trends: Insights from the 2009 Deal Points Study on Private Targets." The MP3 is available here.

If you want full access to this and the many other valuable studies published by the subcommittee, you must be (or know really well) an active member. You can directly sign up for update alerts here.

One supplement already in the pipeline focuses on financial sellers (i.e., VCs and private equity groups). Benchmarking "financial seller deals" with the Study sample generally, the subcommittee is trying to answer the age-old question: "Do financial sellers really get a better deal?" It expects to release this supplement at the Subcommittee's meeting in Denver (April 23-24)

Agreements to purchase private companies often include a post-closing purchase price adjustment (generally based on closing working capital versus some agreed upon target). In an effort to ascertain current market practice, White & Case surveyed 87 private company purchase agreements that were publicly filed in 2008 and contained purchase price adjustments. Full report here.

After the deal closed, Allegheny discovered that some of the key financial information Merrill provided in due diligence was false. The facts get very complicated at this point, in part because the Merrill employee running the GEM business prior to the transaction had embezzled millions of dollars from Merrill (he’s now in jail) and in part because of disputes about accounting methodologies used in preparing the information. The parties disagree about exactly which statements in the information Merrill produced in due diligence were false, why they were false, and what various of Merrill employees knew or should have known about their falsity at the time the agreement was signed.

Because of these problems, Allegheny subsequently failed to honor a put right in the agreement and make a $115 million payment to Merrill. Merrill sued to compel this payment and Allegheny counter-claimed for fraudulent inducement and breach of the representations in the agreement. The lower court dismissed Allegheny's counter-claims after a bench-trial, but the Second Circuit reversed. I refer you to Prof. Miller's cogent analysis for the reasons why -- but basically the opinion was a straightforward application of New York law on the issues of fraudulent inducement and breach.

The interesting thing is the following representation in the purchase agreement by Merrill warranting that the information provided by Merrill to Allegheny was “in the aggregate, in [Merrill’s] reasonable judgment exercised in good faith, is appropriate for [Allegheny] to evaluate [GEM’s] trading positions and trading operations.” As Prof. Miller notes this representation:

should take the breadth away from any practicing . . . . Merrill is representing that the information it provided was “appropriate” for Allegheny’s evaluating the business. At the very least, this means that Merrill is warranting that it reasonably believed that it delivered all the information that Allegheny needed to value the business. Hence, omissions from due diligence will become actionable. If Merrill had any information it did not produce to Allegheny in due diligence, Allegheny will now argue that such information was reasonably necessary for it to value the business and so its non-delivery to Allegheny was a breach.

By agreeing to this warranty Merrill was essentially placing a high burden on itself to justify any omissions from due diligence in the case of any disputes. The representation can also be reasonably interpreted as warranting the truth of Merrill's due diligence materials, an unbelievably wide-reaching representation. The provision is very unusual, and it is likely that Merrill agreed to it knowing this fact due to potential abnormal problems in the due diligence process prior to signing. Nonetheless, as Prof Miller again observes, given its scope it is unlikely Merrill was fully advised by their lawyers of the ramifications of this representation, who themselves may not have realized what they were agreeing to. Although a charitable view is that Merrill fully knew what it was doing but agreed to this bargain based on its limited liability under the indemnification provisions. Pure speculation since I have not seen the actual purchase agreement.

Ultimately, one of the things this dispute and particular representation highlight is the caution M&A lawyers must have in drafting representations. I was often shocked in private practice to find that M&A lawyers in both the big shops and otherwise often didn't have a full grasp of the scope and ramifications of representations instead preferring to over-rely on the "form". When they strayed they often agreed to overly broad or vague representations without appreciating the potential liability created. In addition, many lawyers lacked complete understanding of the relationship between these warranties and the indemnification provisions in private agreements. For example, they often failed to recognize the need to strip materiality qualifiers out when a de minimis was present, failed to generally appreciate double materiality qualifiers and their effect on closing and indemnification, and often argued vociferously that the limitations on indemnification should apply to the covenants. I think much of the reason for this is firm incentives to train associates are diminished in the billable hour world and instead the firms tend to over-rely on their form and network effects (i.e., they will learn on the job from other attorneys) to substitute for this needed training.

Prof. Miller and I have had an off-line conversation on this case. I understand he is going to write a post on it over at Truth on the Market which I will link to when it is up.

An earn-out obligates a buyer to pay additional acquisition consideration if the target, post-acquisition meets certain performance bench-marks. By permitting the buyer to agree to a seller's higher asking price but obtaining assurance that the value promised by the seller will still exist, earn-outs can thus be a valuable tool to resolve an impasse over price between a buyer and seller. But earn-outs have their own problems:

The seller will request the buyer to agree to properly operate the business post-acquisition so the sellers have a greater chance of receiving the full earn-out. This will likely lead to the imposition of complex drafting restrictions and obligations put upon the operation of the business -- provisions which may hamper the buyer's ability to flexibly operate the business.

If the business goes sour, charges by the sellers will inevitably arise that it is the result of poor decisions by the buyer and they are still entitled to the money -- these charges will undoubtedly find colorable support in some of the broad language typically included in the earn-out about using "reasonable best efforts" to operate and promote the business and other optimistic statements in the agreement.

Things change -- earn-outs can go for several years, and the restrictions and other provisions governing the business may not provide for such events.

The need to actually determine if the earn-out is fulfilled often results in pitched battles between the buyer and seller and charges of accounting manipulation. M&A lawyers therefore have to be very careful to highlight these difficulties to their clients, and attempt to negotiate provisions in earn-outs which either willfully address or otherwise omit covering these issues. All this without over-drafting and making the earn-out terms too complex. Earn-outs are a trap for the unwary.

All of this went through my mind as I read Chancellor Chandler's opinion issued earlier this week in LaPoint v. AmeriSourceBergen Corp., No. 327-C (Del. Ch. Sept. 4, 2007). In LaPoint, AmerisourceBergen had agreed to acquire Bridge Medical Inc. for an initial payment of $27 million dollars, and further agreed to an "earn-out” to be paid to former Bridge shareholders contingent upon certain EBITA [earnings before interest, tax and amortization] targets being met over a two year period. The earn-out payment varied between $55 million and zero, depending on the EBITA of Bridge achieved in each of those years. Chandler describes the dispute as thus:

This case falls into an archetypal pattern of doomed corporate romances. Two companies Bridge Medical, Inc. and AmerisourceBergen Corporation—agree to merge, each convinced of a happy future filled with profits and growth. Although both partners harbor some initial misgivings, the merger agreement reflects these concerns, if at all, in an inaccurate and imprecise manner. After some time, the initial romance fades, the relationship consequently sours, and both parties find themselves before the Court loudly disputing what the merger agreement “really meant” back in its halcyon days.

If this case is different, it is only in the speed with which the ardor faded. Both parties now assert that mere months after the ink on the merger agreement had dried, if not before, their erstwhile paramour had determined that the relationship was not worth the candle. Plaintiffs (former shareholders of Bridge) insist that defendant provided lukewarm support for their operations and did everything possible to avoid having to pay merger consideration contingent on the success of plaintiffs’ former firm. Defendant blames plaintiffs’ woes upon plaintiffs’ lack of long-term planning, inconsistency between plaintiffs’ strategies and actions, and an inability to cope with market changes. Plaintiffs now seek damages in response to defendant’s alleged breaches of contract.

The first charge leveled by the plaintiffs was breach of the earn-out provisions in the acquisition agreement due to ABC's promotion of other competing products, changes to Bridge's publicity policy and general failure to actively and exclusively promote Bridge products. Importantly. ABC had agreed to the following provision in the agreement:

[ABC] will act in good faith during the Earnout Period and will not undertake any actions during the Earnout Period any purpose of which is to impede the ability of the [Bridge] Stockholders to earn the Earnout Payments.

ABC had also agreed in the agreement to "actively and exclusively" promote Bridges products. Chandler ultimately found that "ABC frequently and intentionally breached its duty to provide active and exclusive support for Bridge sales efforts," but since it did not affect the business's failure to meet the earn-out targets only nominal damages of six cents were appropriate. Nonetheless, Chandler ordered ABC to pay plaintiffs $21 million arising from ABC's miscalculations of the earn-out. Here, plaintiffs had charged that ABC had intentionally miscalculated the earn-out appropriate for 2003 by giving too high a discount on a significant sale, making too big an adjustment to EBITA to account for R&D expenditures and postponing recognition of another significant sale. ABC has announced they will appeal. Given the deference provided the Chancery Court by the Delaware Supreme Court and the fact-based nature of Chandler's determination, I'm not sure it is worth their money. Again, earn-outs can be helpful in achieving a deal, but they are a trap for the unwary.

The Wall Street Journal is reporting that Home Depot has agreed to cut the sale of its wholesale supply unit to $8.5 billion, eighteen percent less than the $10.325 billion agreed to a few months earlier. The sale to affiliates of Bain Capital Partners, The Carlyle Group and Clayton, Dubilier & Rice will likely close this week on this basis. The deal is important because it is the first time in this market crisis that private equity firms have relied upon their reverse termination fee "option" to substantially drive down the price of an acquisition. It is also shows how stretched the banks are these days and the lengths that they are going to keep private equity debt off their books.

Like may other private equity agreements, the sale agreement for HD Supply specifically limited the private equity consortium's damages in case it decided not to close the transaction for any reason whatsoever, and specifically excluded the option of specific performance. Here, the agreement limited the consortium's damages of no more than $309,750,000. As I have written before, many private equity deals contain this provision; and in this volatile market and the current credit-squeeze the option like nature of these provisions cannot be ignored. This was the case here as, according to the Journal, the banks who agreed to finance this transaction, including JP Morgan Chase, actually offered at one point to pay this fee on behalf of the private equity consortium if they agreed to walk. This is bad, folks.

That the banks would go these lengths shows how desperate they are to avoid the situation First Boston found itself back in '80s when it got stuck in the "burning bed", unable to redeem hundreds of millions it had lent for the leveraged buyout of Ohio Mattress Company, maker of Sealy mattresses. First Boston only escaped bankruptcy by being acquired by Credit Suisse. In the case of HD Supply, the banks apparently asserted that they were no longer required to comply with their commitment letters to finance the acquisition because of the prior agreed change in the purchase price and the revised market conditions it reflected. The position seems a bit tenuous, but I don't have all the facts, and the letters aren't publicly available. Ultimately, though, it appears the need of all the parties to save reputation in the markets as well as Home Depot's need to finance its share buy-back, pushed them to a deal; according to the Journal, Home Depot is providing guarantees on part of the six billion dollars in bank financing provided in connection with the leveraged buyout deal as well as taking up to 12.5% of the equity, while the private equity firms are putting in more equity.

Of greater significance is the fact that the parties would go to these lengths to renegotiate a deal, and make the threats they have around the reverse termination fee. This doesn't bode well for the many other private equity deals in the market today that have this similar reverse termination fees (e.g., SLM, TXU, Manor Care, etc.). As we move into Fall and the banks begin to sweat their liability exposure, expect more re negotiations and a high chance that the economics of one of these many deals will become so bad that either the private equity firms or their financing banks will blink, taking the reputation hit, walking away from the deal and paying this fee. Food for thought as you chew your hot dog over this upcoming Labor Day weekend.

Final Point. The banks and private equity consortium will spin this as a MAC case, but a review of the definition of MAC on pp. 5-6 of the merger agreement finds a weak case for that (the MAC contains the standard carve-out for changes in the industry generally and markets except for disproportionate impact; it appears to be a tough case to establish here). I believe the banks and buying consortium will claim the MAC in order to publicly cover for the raw negotiating position they have taken by using the reverse termination fee and threatening to walk.

NB. Home Depot's counsel on this transaction was again Wachtell. Interesting, given the criticism Marty Lipton received in advising Nardelli on his infamous "take no questions" shareholder meeting.